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The Ultimate Question: Deflation Or Inflation? at Trader’s Narrative

The Ultimate Question: Deflation Or Inflation?

If I could know one single data point from the future, it would be whether deflation or inflation won the economic battle royale of this new decade. That is the ultimate question that will decide the future price of almost every single asset: real estate, gold, equities, bonds, etc.

Not surprisingly, this single question is the focus of many of today’s “gurus”. For example, Michael Belkin and James Montier believe that ultimately, inflationary forces will prevail and as a corollary, the bond market is nothing but a big, fat, bubble.

Others like David Rosenberg and Robert Prechter side with deflation. And they have a lot of evidence to back that up. For example, the recent core CPI for January came in negative (-0.1%). The first monthly drop we’ve seen since 1982! Even if we annualize the time series, things don’t look that much better. The annual trend for CPI is a feeble 1.6% and 1.0% for the PPI.

Press play to see video:

No one in the bond market is falling over themselves to buy TIPS (Treasury Inflation Protected Securities). The last auction on Monday was met with a yawn. Right now TIPS are implying an inflation rate of 2.3% for the next decade. But if you believe that markets are perfect discounting mechanisms, capable of foreseeing the future, then you obviously have not been around for the fireworks we just had for the past two years.

Prechter (see videos) is not only warning about deflation, he also believes that we are at a “grand, super cycle top”. He points to several charts to prove his view. For example, the Value Line Geometric Index which topped out in April 1998 and again in July 2007. And the mutual fund cash levels, which we’ve talked about several times before here. He believes that retail investors are simply making the next big mistake by rushing into bonds. For more, see the current issue of Global Market Perspective. Also interesting, see the video where he explains the paradox of why deflation will be good for the US dollar:

Press play to see video:

In contrast, Belkin is forecasting higher inflation because he believes that eventually all that money sloshing around the economy will stoke higher prices. By the way, the minimalist in me (or is that simpleton?) can’t but admire the way Belkin peppers his charts with these up or down arrows:

US CPI forecast Michael Belkin Jan 2010 Welling Weeden

Belkin believes that for now, the recovery is real:

All of my indicators on things like industrial production and manufacturing, the ISM indexes, and, particularly, inflation, point up.

…the inflation rate, which just came out last week, the CPI, is 2.8%. So we’ve got a negative real Fed funds rate of 2.5% or so and that always creates mischief. It’s like opening Pandora’s Box. So my hunch is - I strongly suspect that the bond market and fixed income securities are going to become the next major source of losses for the public.

Keep in mind that the above snippet is from his interview with Welling@weeden last month. Although, he was expecting the market to whistle a different tune by June 2010, it is entirely possible that he’s already changed his mind.

If you happen to be a time traveler from the future, drop me a comment below on what really happens.

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4 Responses to “The Ultimate Question: Deflation Or Inflation?”  

  1. 1 joel

    I don’t know if social mood was talked about with prechter but that is thedeciding factor.

    People are trying to payoff debt. Deflationary

    People are saving more. Deflationary.

    Housing prices are well deflating.

    When people save money and not use the money it takes money out of circulation. This is deflationary.

    I am buying tips on the dips.

  2. 2 JBR

    What’s interesting is that both sides (Prechter and Belkin) say the bond market is a huge bubble…

  3. 3 jagmohan swain

    JBR you nailed it.No matter who wins bonds lose.:)
    Hard to predict who would be the winners, more likely that sometimes inflation will win, sometimes deflation.Gun to head,I see a stalemate, inflation now deflation later followed by inflation :)

  4. 4 Fibocycle

    Babak: I have put another interesting FIBO chart up at the blog–Saint Paddy’s day could be interesting.

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